Many small businesses are still recovering from the COVID-19 pandemic. As a result, many small business owners are focused on reducing their operation costs and maximizing profits. ‘
Business operators understand that tax efficiency is one of the top ways to save money and have enough to reinvest in the business.
Tax planning is a significant part of any small business. As a sole proprietor, you can significantly reduce the amount you pay in taxes by implementing smart saving strategies.
Luckily, the IRS provides numerous tax breaks to small business operators to help them make enough money to survive these tough times. Here are some ways you can reduce taxes for your small business.
1. Fund Your Retirement Plan
Owning your business usually means you give up the 401(k) usually matched by an employer. However, funding your retirement plan for both you and your employees can help you make significant savings on taxes.
Small businesses have several retirement plan options to choose from including SEP IRA and Solo 401(k). These qualified plans help you take advantage of tax savings by allowing deferment of taxes on your earnings.
Choose the best fit depending on your needs or consult a professional tax advisor to help set up your retirement plan.
The contributions you make towards your retirement plan are deductible on your tax returns as an individual.
If you are funding your employees’ retirement plan, your business contribution could also be deductible as an expense.
Businesses that create and offer a qualified retirement plan for their employees may also be eligible for business tax credits of up to $500 which can be used to offset educational or administrative expenses.
2. Qualified Business Income Deduction
Sole proprietorships, partnerships, and S corporations are eligible for Qualified Business Income deduction. This tax deduction allows you to deduct up to 20% of your qualifying business income on taxes.
Your business may also qualify for the QBI deduction in addition to its ordinary expense deductions.
Small business owners qualify for QBI if they make over $315,000 and are married filing returns jointly or making below $157,000.
There are other limitations and restrictions to QBI including the amount of W-2 wages paid by the business, type of business, and amount of income that qualifies for the deduction.
Consult a tax advisor to find out whether your business is eligible for a Qualified Business Income deduction.
3. Defer Your Income
Tax season is the best time to minimize income to reduce assessable income which is directly proportional to taxes. You should also aim to maximize business expenses during this time.
Commonly referred to as deferring your income, this method uses accrual accounting to stay ahead of your income and expenses.
You will still pay taxes on the deferred income in the next tax year however, you’ll have saved money that you can use to expand the business in the current year.
4. Purchase Equipment and Vehicles
Depending on the type of business, you can enjoy tax write-offs when you buy machinery, equipment, and vehicles. In some cases, buying real estate will also help your business qualify for write-offs.
Section 179 allows you to deduct the cost of equipment as an expense when you put the equipment to service. This deduction applies to tangible property such as any machinery bought for use in your business.
In 2018, the minimum deduction was adjusted to $1 million following the Tax Cuts and Jobs Act.
Bonus depreciation allows businesses to deduct a large percentage of the buying price of assets such as machinery instead of writing them off over their useful life. As of 2017, TCJA increased bonus depreciation to 100% from 50%.
If you have bought or are planning to buy major assets for your business, consult a tax professional to find out whether you are eligible.
5. Write Off Bad Debts
Check your books during tax season and review customer accounts. Aged or unpaid accounts can qualify you for tax write-offs on your taxes. When a customer account remains unpaid, you can write it off as bad debt and reduce your business’ tax burden for the tax year.
You will need to find out whether the customer is incapable of paying their bill before writing them off as future settlement may involve reversing the write-off.
Bad debt may also include loans issued to employees, clients, and vendors who did not pay you back. Talk to your tax advisor before writing off bad debt to ensure the process is handled properly.
6. Consult a Professional Tax Auditor
Before you make any decisions to reduce taxes for your small business, always consult a professional tax auditor.
A qualified tax auditor or tax lawyer can help you make sound business decisions all year that will prepare you for tax season.
Consider hiring a professional who is conversant with IRS regulations and can offer representation in case of an audit.
Enrolled agents who have previously worked with the IRS and passed a three-part test are the best suited for this role.
Learn More About How to Reduce Small Business Taxes
When it comes to tax planning, always think ahead. The tips listed here may help you reduce taxes for your small business, but they do not protect you from penalties and are not intended as tax advice.
Each business is unique and with tax laws changing frequently, it is important to stay updated. While owning a small business can be challenging, taking the time to understand your financial position can help you succeed and grow.
Carefully account for all deductions throughout the year and engage a professional to help you find alternatives that can help you save on taxes.